Q: Is there ever a situation where depreciation expense is shown in cost of goods sold? Why would depreciation expense be included in COGS?
A: Depreciation may be an expense in the array of expenses for cost of goods sold as well as an expense in the array of operating expenses. It depends on the use of the fixed assets subject to depreciation. If the fixed assets are used to directly produce goods, such as machinery, the depreciation expense associated with these fixed assets is charged to cost of goods sold. If the fixed assets are used to support the general operations of the business apart from directly producing goods, such as office equipment for the accounting department, the depreciation expense associated with these fixed assets is charged to operating expenses.
In the final analysis, the accountant decides on the allocation of depreciation expense. The important point is that all of it is accounted for and is consistently allocated and consistently applied year after year.
Q: What is the difference between depreciation and the. Section 179 Deduction amount?
A: The Section 179 Deduction amount is not used in preparing the accrual income statement and accrual balance sheet. GAAP does not recognize it as an acceptable expense. Therefore, no amount of a Section 179 Deduction is used in preparing and presenting an accrual income statement and balance sheet.
The Section 179 Deduction is only used in preparing business and personal income tax returns. Its sole purpose is to reduce taxable business and taxable personal income and, therefore the amount of taxes paid. It applies only to federal taxes.
For a Subchapter C corporation and sole proprietorship, the Section 179 Deduction is accelerated depreciation that allows for 100% of the cost of a qualifying asset to be depreciated the year it was placed into service. On the business income tax returns for these two business entities – Schedule 1120 in Form 1120 and Schedule C – the Section 179 Deduction amount is added to depreciation expense for non-Section 179 Deduction assets in reducing taxable business income.
Therefore, depreciation expense used to determine taxable business income for a Subchapter C corporation and for a sole proprietorship is the sum of a) the Section 179 Deduction amount and b) the depreciation expense for the year on those business assets that were not included in computing the Section 179 Deduction.
For Subchapter S corporations, partnerships, and limited liability companies, the Section 179 Deduction amount is NOT used in the array of tax-deductible expenses that result in taxable business income on the business income tax returns. Depreciation expense reported on Schedule 1120S for a Subchapter S corporation and reported on Schedule 1065 for a partnership or limited liability company is the depreciation expense for the business assets that were not used in computing a Section 179 Deduction.
The Section 179 Deduction amount, however, is reported by the owners or partners of these pass-through business entities on their personal income tax returns as a reduction to taxable business income passed to them by their companies. (Recall that owners and partners of these pass-through entities are responsible for paying the income tax obligation on their company’s taxable business income.) It drives down their taxable income by the same amount as the Section 179 Deduction reduces taxable business income for a Subchapter C corporation and sole proprietorship.
In the final analysis, the reduction in federal taxable income is the same regardless of whether the business enterprise is a Subchapter C corporation, a Subchapter S corporation, a partnership, a limited liability company, or a sole proprietorship.
Q: What about FF&E re-capture when an asset is purchased?
A: If a used asset with a carryover amount is purchased, the buyer may use the carryover amount in computing the Section 179 Deduction. But if the full Section 179 Deduction has been previously used by the prior owner, then nothing is available for the new owner.
Note that the Section 179 Deduction amount is based on historic cost and not on resale price.
Course overview: Understanding Schedules K-1